Cash back is a type of credit card reward you may hear about often. Whether you're new to or have been taking advantage of this benefit for a long time, you may wonder how it works. So why do credit cards give cash back, and where does the money come from?
Credit card cash back, explained
Cash back is a cash rewards program offered by some credit card issuers. Not every card has this benefit, so be sure to do your research if you're looking for one that does. When you use a cash back credit card on a qualifying purchase, you earn a percentage of the amount paid.
How can credit cards give cash back?
There are three main revenue sources for issuers:
- Cardholder fees
- Merchant fees
Card issuers use the money they make from those sources to be able to fund their rewards programs. Some cash rewards programs do have limits, meaning there may be an annual maximum amount of cash back you can earn. This differs between cards and issuers, so be sure to check your terms and conditions for specifics.
One of the reasons you may hear about cash back often is that it may appeal to both consumers and issuers. The potential to earn rewards creates yet another incentive for cardmembers to potentially use their credit card over other forms of payment.
Types of cash back
There are four main types of cash back credit cards.
- Flat-rate cash back: This is a common type of cash back card. It offers a singular rate across all spending categories. The percentage will vary among cards, but 1.5% and 2% are typical examples.
- Bonus categories: The cash back percentage on this type of card will vary among spending categories. For instance, your card may offer higher percentages on things like gas station purchases, dining or travel, and then a lower standard rate for all other categories.
- Rotating bonus categories: This is similar to the bonus categories type of card, except they rotate — the bonus categories generally change quarterly. Issuers may offer bonus cash back on gas stations and grocery stores one quarter, and restaurants and drugstores another.
- Customizable: As its name implies, the customizable cash back card allows you to customize your bonus categories. You can pick which category gets the highest cash back percentage from a list provided by the issuer.
Spending your cash back
How you spend your cash back may depend on your card. Some issuers automatically apply your cash back as a statement credit, while others might offer you the choice between statement credit, check or direct deposit into another account.
With a card like the Chase Freedom Unlimited, you can redeem your points earned for a cash back statement credit or direct deposit. You can also use those points for things like gift cards or travel if you book through Chase Ultimate Rewards.
If you decide to take advantage of earning cash back, you can then use that money in a variety of ways, including things like:
- Paying off debt: You can put the money toward paying off your balance on a credit card or loan.
- Creating a fund for unexpected expenses: You may want to save the money for planned or surprise expenses — that way you may be more prepared to pay for new car tires or to replace your dishwasher when it breaks.
- Adding to your emergency fund: You can put your money into your emergency fund, so that if you face an emergency, you may be better equipped to afford your usual expenses.
- Investing in retirement: You may consider putting your extra money toward your future retirement.
- Saving for big goals: You can potentially put that cash back toward saving up for any big purchases you may want to make in the future, such as a house, a new car or a bucket list trip.
Some cards will also let you redeem your cash back for gift cards to popular retailers, or as points in their travel portals to save money on travel bookings. The options for cash back redemption can vary greatly depending on your card and issuer.
So, why do credit cards give cash back? Because they incentivize cardmembers to make purchases using their card and reward cardmembers for everyday spending. If you use your card responsibly, a cash back credit card might be a rewards system to look into. You could potentially see rewards just for spending money on everyday purchases — from groceries and gas stations to dining and travel.